You have an idea for a project. You have performed some analysis and predict that your project will generate the following average cash flows. It will cost you $1,000,000 in investment at t = 0. At t = 1 you will have to spend an additional $120,000. At t = 2 you will have a positive cash flow of $100,000. Thereafter, the expected cash flows will grow at a 3 percent rate every year forever.
These cash flows are risky and have the same risk as the types of projects that XZX Co. has. You have collected the following data on XZX Co. XZX Co. will pay a dividend only once a year. The next dividend is expected to be $2 per share and is expected to grow at 2 percent every year forever. The current price of XZX Co. is $25.
A. Given that investors who might invest in your project have the opportunity to invest in XZX Co., what is the opportunity cost of capital for your project? That is, what is the return investors in XZX Co. must be demanding is they are willing to pay $25 per share?
B. Using the discount rate demanded by XZX Co. investors, what is the t = 0 present value of positive cash flows you have predicted for your project from t = 2 and beyond?
C. Using the discount rate demanded by XZX Co. investors, what is the t = 0 present value of the costs for this project incurred at t = 0 and t =1?
D.Does it make sense to pay these costs to get the future positive cash flows (that is, does it make sense for you to adopt this project)?
If you could show your work so I can understand how you got the answer, that would be wonderful. Thanks!